Even 'Safe' Bond Investments Falter as Markets Tumble

By Stan Choe and Sara Skidmore

Traders work on the floor of the New York Stock Exchange (NYSE) Friday morning on Feb. 9, 2018 in New York City.
Spencer Platt/ GettyImages

The stock market isn't the only thing dropping. Bonds, which are supposed to be the safe part of every investor's portfolio, have faltered, too.

In what's been a rude awakening for some investors, bond funds have lost ground these past couple of weeks, unlike in past downturns for stocks. What's different this time is that the same things undercutting stocks are hurting bond prices: worries about inflation and the possibility of much higher interest rates.

Marjory Stoneman Douglas High Sophomore Emma Gonzales had a message for president Donald Trump and for other politicians on their failure to enact sensible gun laws: "BS." Gonzales was one of several survivors to speak at a rally held outside the Federal Courthouse in Fort Lauderdale, Florida, to speak out against the gun lobby.

(Published 3 hours ago)

Bond losses have been more modest than the setback for stocks, but more may be on the way. And swings in bond prices are likely to become more common than in recent years, when returns were unusually smooth, experts say.

Nevertheless, experts are sticking with the mantra that bonds will be safer than stocks and that investors can continue to count on them as a stabilizing force for their portfolios.

Deputy Attorney General Rod Rosenstein announces indictments against 13 Russians and three Russian entities accused of meddling in the 2016 U.S. presidential election.

(Published Friday, Feb. 16, 2018)

Instead, while stocks were dropping 10 percent from their record high, set on Jan. 26, the largest bond mutual fund lost 0.8 percent through Thursday.

The spark that sent markets tumbling was a report last week that showed wages in the U.S. are rising faster than expected. That raised concerns that inflation may be on the way up, which could force the Federal Reserve to increase interest rates more quickly than expected.

When the Fed raises rates, bonds typically begin paying more in interest. That's good for investors who buy those more lucrative, newly issued bonds. But the old bonds sitting in bond funds' portfolios see their prices drop, because they suddenly look less attractive than the new ones.

Inflation, meanwhile, is one of the worst enemies for bond investors, because it dilutes the value of the fixed payments that bonds make.

Even before the inflation worries flared, bond fund investors were jittery because the Fed has been slowly winding down the measures it took to stimulate the economy during the Great Recession. The Fed is raising short-term interest rates and reducing its large holdings of bonds.

Because of that, investors need to recalibrate their expectations for how steady bond funds can be, particularly after the unusually calm stretch that investors have enjoyed.

The index that many traditional bond funds measure themselves against, the Bloomberg Barclays U.S. Aggregate, has had one loss in the last eight quarters. Going back to 1980, the index has had a loss about 20 percent of the time, or one in five quarters.

"People have become quite trained on seeing only positive returns from their bond funds," said Mike Dowdall, investment strategist at BMO Global Asset Management. But he said negative returns are to be expected every now and then.

Chanting "enough is enough" and waving signs emblazoned with messages like "No more silence, end gun violence," hundreds of demonstrators gathered outside the Federal Courthouse in Fort Lauderdale Saturday to rally for stronger gun control laws.

(Published Saturday, Feb. 17, 2018)

And "that's OK," he said. Bonds and bond funds are "still going to provide income, and it still makes sense to have that diversification."

Even if rates rise, experts say it's very unlikely that a bond fund would have losses as sharp as stocks are capable of. Bonds make regular interest payments, which helps steady their returns. And if a company goes bankrupt, bondholders are ahead of stock investors in the line to get their money back. U.S. government bonds, meanwhile, are considered virtually free of risk of default.

That's why bonds rallied in 2011, when stock markets around the world tumbled on worries that Europe's debt crisis would tear apart the European Union, in 2008, when the financial crisis hit its depths, and in 2000, when the dot-com bubble was bursting.

If the upcoming rise in rates is a smooth one, the increased payouts that bonds will make could help offset the drops in price that bond funds suffer and smooth out returns, said Chris Brown, a portfolio manager at T. Rowe Price.

Students and faculty of Marjory Stoneman Douglas High School passionately spoke out at a gun control rally in Fort Lauderdale, Florida, three days after an alleged gunman opened fire and killed 14 students and three school staffs.

(Published Saturday, Feb. 17, 2018)

That's why he suggests investors muddle through the volatile patches, such as the last couple of weeks where both bond and stock prices went south.

"On any given day, you might see the relationship flip on its head, where bonds go down and stocks go down," he said. "This week has been pretty topsy-turvy, but on the worst days (for stocks), you saw bonds do exactly what you thought they would do: They rallied."